Sunday, June 26, 2011
Saturday, June 25, 2011
Friday, June 24, 2011
Saudi Arabia stated that they would add to production to make up the shortfall of Libyan. It has been a slow process because turning on of an oilfield is not a slip of a switch. However, the 4% decline hit all oil producers with a loss. Why not let the US use all of its oil first?
Have oil prices slowed global growth? Of course, but bad governance with the EU and Greece may have had a bigger effect. Do not watch our bad fiscal behavior, we will try and punish speculators.
Thursday, June 23, 2011
Tuesday, June 14, 2011
The same effect can be found if the analysis uses the EFA index or an emerging market index. Similarly, there is a stronger negative relationship with bonds than what existed pre-Lehman. The link between asset classes has become stronger and it is more important to think about the relationship across asset classes.
The trade issue has to be viewed through a micro lens of products and dollars moving. Trade also has to be viewed through the macro problem of savings flows. We have to move away from gross trade imbalances.
The reaction has been mixed given other news in the markets; nevertheless, we expect that this will have a negative effect on commodity markets. Managing a growth slowdown is very risky. Upside risk is a different story. Who cares if you have excess growth as long as the direction is right. The traditional view is that the economy has to be slowed since inflation is high, but what if inflation is caused by structural issues? If this is a price shock to food and energy and the constraints on trade, then increasing the RRR is not going to be effective.
The spending multiplier is critical for the success of any stimulus program. A low spending multiplier means that there will not be any follow-through from the increase in government spending. Hence, the value of a new spending program should be questioned as unproductive. A high spending multiplier will mean that a dollar of fiscal spending will translate into more than a dollar of GDP. The spending multiplier will be lower if there is an interest rate effect whereby increase spending will lead to higher rates based on the crowding out effects. If rates rise, then private spending may decrease, lower the impact of any government spending. If there was no interest rate effect, then the multiplier will be higher.
The spending multiplier is not stable because the interest rate environment is variable. If the economy is in a zero interest rate environment then there will be less interest rate effect which will drive the multiplier higher. The deflationary spiral or the paradox of thrift will place the economy at risk and there potential move in interest rates will be limited. Hence, this would be the time to use fiscal stimulus to get the economy moving. If there is expected a longer zero bound environment, the multiplier will be larger.
While it is difficult to advocate, there is a reason for controlled policies to help the economy move. The limited rate effect means there will be greater bang for every dollar spent.
Monday, June 13, 2011
In fact, an IMF second bail-out of say Greece would be a bail-out of the French banks. Candidate Lagarde is the Finance Minister of France. How hard would a European bargain at this time given the EU would be a beneficiary. This argument would not hold for past Europeans since their nomination was not occurring during an EU crisis. Who would Lagarde represent?
Sunday, June 12, 2011
Hence, if you want to have an impact on the economy the size of the stimulus will have to be based on the potential sensitivity. A higher sensitivity will mean a greater impact for any dollar used. Given this information, we should see more real effects from monetary effects. In reality, the sensitivity has been less than expected. The current environment does not fit past behavior; consequently, we have to plan for a different world.
Raghuram Rajan, University of Chicago professor
The passive strategy of letting principal and interest roll-off would seem to be the easiest means of reducing the balance sheet. The mortgage portfolio actually is over $100 billion smaller than a year ago just because of principal and interest declines. Still, the problem will be the speed at which the portfolio will decline. If growth will be slow, there is less desire to have the portfolio decline. On the other hand, cash flow could be used to buy more securities and hold the balance sheet stable. At this time, it s not clear hat is the specific Fed plan.
Saturday, June 11, 2011
A simple regression of beta between the EFA and EEM stock indices and the SPX shows that the beta for developed stock markets has risen over the last two years relative to the five years prior to the Great Recession. At the same time the beta for the EEM index has fallen over the last two years. We took out the volatile recession period as abnormal; however, when the last three years are used the same results apply. There is a marked decrease in volatility with emerging markets.
Jamie Whyte, in an FT editorial, "Why our masters insist on breaking the rules" provides an interesting perspective on the crises within the EU. The EU has tried to provide stability and structure within the union but whenever there have been times to avoid following the rules countries and the group as a whole have always chosen to break the rules.
Remember that budget deficits were never to be above 3% of GDP. Everyone, even those who developed the idea of budget constraints, has broken the rules. If the budget deficits were all below 3%, the crises never could have occurred. There were supposed to be penalties. None were imposed. There were supposed to be no bail-outs, yet they have occurred. There was supposed to be no acceptance of non-investment grade collateral yet the ECB has accepted all bonds.
This gets back to the issues of creditability from governments. There is little. The issue was addressed in the 1980's with research on time or dynamic inconsistency in monetary policy. The basic idea is that if you do not follow the rules that you place upon yourself there will be limited creditability and policies will have to be more extreme. There is no anchor on what could be the actions taken by government other than they will be addressed at the time of a crisis. This is not a system of government or economics but a system of chaos.
There is the hope that governments in their infinite wisdom will be able to provide the right solution that makes sense. The argument that flexibility is good under the assumption that rational decisions can be made. Do we really have confidence that this can happen in a crisis?
OPEC is relevant to the world oil price. Its relevance comes from the breakdown between parties concerning any new production quotas. Iran with a coalition of other oil producers, Venezuela, Iraq, Angola, and Algeria have been unwilling to increase production in the face of higher prices. Its argument is that production is high enough and that a slowdown in growth could mean the world will have excess supply. Saudi Arabia wanted to have production increases and reduce the pressure on growth from prices above $100 / barrel.
The lack of an accord between OPEC members mean that unilateral action could be taken by countries which destroys any sense of a cartel. Note that production has generally been above quotas and the current gap is actually quite wide. The issue is not quotas as much as having production match the specific target of the group. This has generally not occurred. The real problem with an OPEC dispute is that it provide another backdrop of uncertainty about the dynamics of global oil supply.
Why are equity markets rising on bad economic information? A reasonable story is that the markets are expected a QE3. There were some clear objectives with QE2, raise risky asset prices to stimulate the economy, raise housing prices to help consumers, and increase inflationary expectations to offset the ravages of deflation, and cut the value of the dollar to help exports.
They were successful on some fronts. The dollar is lower and exports have increased. Unfortunately, the higher oil price have hurt the terms of trade and the balance of payments have not improved as much as expected. The housing market has stabilized but there is little improvement. This stability is very tentative given that housing is still on the ropes just not as bad as before. Stocks are higher even though corporations are having a hard time making investments decisions and have continued to hoard cash.
The latest Bernanke speach tlks baout an uneven economy so there is still something needed by the Fed. Theonly real option is buying more securities, so it is just a matterof time. If the eocnomy looks weaker, the chance of QE3 increases and forward looking markets will increase in price.
The NYMEX crude oil contract reflects the price of WTI delivered to Cushing Oklahoma. Brent is a international reference for North Sea oil that is closer to the light sweet crude coming out of Saudi Arabia. WTI delivery is to a land-locked delivery point tied to a pipeline intersection. It is hard to get oil out of Oklahoma and to the coast so that it can be sold on the international market. Hence, if there is a strong increase in US onshore production as well as more oil coming down from Canada it cannot leave the US. The result is oversupply and a dislocation relative to other oil prices. In fact, the price of oil along the gulf coast better reflects the international price and not the NYMEX price.
In politics, it is often said that everything is local. The same may be said for commodities. Regardless of what is going on in the macro economic environment. Futures will have a localized component that can dominate the broader demand and supply for a commodity. This is one of the key reasons for why contract specifications are so important in the futures markets. The failure of futures contracts will often be associated with contract deliver issues which causes wide fluctuations in the basis of difference between cash and futures.
We expect that this differential will not go away anytime soon, so there is an opportunity for new futures markets to develop. The chance of failure is high, but there will be a growing demand for new options. This dislocation of the US market from the rest of the world also occurs in natural gas. Oddly, all of this fragmentation between the US and the rest of the world is occurring at a time when the rest of the world is becoming more dominant to commodity markets.
There was nothing wrong with Peter Diamond the MIT Nobel prize winning economist being a Fed governor. He is a brilliant economist who has worked to advance our understanding of labor markets and problem of information. He is insightful and well-respected within the academic community. He is not a banker or a regulator, but he has a strong mind with respect to key problems in our economy. The Fed has a mandate to reach full employment and it makes perfect sense to have a labor specialist on the Fed’s Board of Governors. This was a mistake. Politics should not have played a role in the decision. I wish him better.
China has $3 billion in foreign exchange reserves with 2/3 likely in dollars. There is a going concern that the US government is not troubled about what my happen to the value of these investments held by foreign governments. Why care about foreign buyers? The only thing that matters is whether US voters are happy and the economy is growing.
Still, large buyers on becoming more vocal with their concerns. As quoted by Guan Tao, the head of international payments department of the SAFE (State Administration of Foreign Exchange),’The US may find it hard to resist the policy temptation of weakening the dollar abroad and pushing up inflation at home.” This sums up the argument from the perspective of foreign bond holders.
With the debt ceiling problem coming to a head and Moody’s talking about a rating decline, China is feeling nervous about their US holdings, but there is little it can do about it. There is not a good option with the euro and there is not enough bonds available from stronger currency countries. The comments are meant to sway the US to a more debtor friendly policy, but it is unlikely that the US will adapt this type of view.
This Chimerica issue of China supply goods and credit while the US is a buyer and debtor cannot last. This will be a growing flashpoint in finance which may become more relevant in the course of the next few weeks.
A new agricultural market information system (AMIS) is an initiative by the G20 to gather and disseminate more information on the production and inventory of grains and other foods around the world. Data will be received jointly from the FAO, international agencies and G20 countries and aggregated to provide a better overall supply picture on critical food markets. (This is similar to the JODI data (Joint Oil Data Initiative) started a few years ago.)
France has been the strongest advocate for this initiative in order to reduce price volatility and premiums associated with the uncertainty concerning what is the supply of different foods. There are wide differences in how information is collected and disseminated in food markets.
The USDA is especially good at providing detailed information on US production, but many countries hold stock information as almost state secrets. The uncertainty about what is the true production and inventories held around the world means that many buyers will purchase first and ask questions later. The result is panic buying that is rational given the uncertainty but in a more transparent market would not make any sense. Markets are more likely subject to speculative attacks when there are large information divergences. If this information gathering is successful, there should be a dampening of prices as the market gains a better understanding of the true supply picture. This will be welfare enhancing.
Whether speculator or hedger, the providing of more commodity information is good for the global economy.
Oil has been up over 21 percent since the beginning of the year as geopolitical risk increased the premium in energy markets. Silver, even with the decline in May, has also increased by over 20% based on strong demand as a substitute for gold. Corn continues its upward movement caused by low inventory and poor planting conditions.
On the other hand, sugar has fallen 25 percent with larger crop harvests that should reduce the supply constraints from last year. Cocoa prices have declined with the reduction in political risk and the flow of supply out of the Ivory Coast. Nickel has seen declines as higher production out of China has increased supply.
Commodities are a diverse asset classes and these broad price differences tell us it is hard to think of this asset class as a single group of markets that move together through time. This differences in correlation is one of the strongest reasons for engaging in active management versus passive long-only buying of an index.
There is no such thing as one size fits all in the commodity markets.
Tuesday, June 7, 2011
Thursday, June 2, 2011
If the rating agencies do their job, there will be less need for the bond vigilantes to have to force activity on the government. Nevertheless, some would argue that there is no need for concern. 10-year rates are now at 3 percent. This level is at the lows for the last six months. If there is a credit problem, rates should not be lower but higher especially with 30/10 spreads. Rates have been fallen on the back of poorer economic news and the announcement of the end of QE2.
Markets can have a strong change in direction. A swift back-up is possible if there is a credit concern and this default risk is real.
How much money is now needed to move the dial toward a lower probability? It is not clear. At this rating, the odds are more likely that a restructuring will be necessary. Little help will come from the ECB who will not take Greek bonds as collateral, and it will be harder for all countries to agree on terms for such low-rated debt.
A "reprofiling" will be necessary. It is just a matter of how much restructuring will be done.
1. surveillance of fiscal and competitiveness policies
2. executive functions with respect to integration of the financial sector
3. the representation of the union with international financial institutions
There has to be better oversight on the budgets of all countries. Most EMU countries have running budget deficits higher than expected by the Maastricht Agreement. There also has to be an integrated approach to bank management and the ability to rise above the self-interest of individual countries.
Still, making major policy changes at critical times is never good. It calls for further integration at the very time that the monetary union has the potential to break apart. This may be the right time to double down on union. Certainly something is needed to change the current system, but further integration may not be the will of the people even though it is a solution to solve the short-run problem of crisis management.